Expanding In Emerging Cannabis Markets Sparks Growth, Yet Federal Uncertainty And Market Volatility Lurk

Key Takeaways

• Expansion into newly legalizing markets and conservative underwriting positions the company for growth while managing risk effectively.
  
• Strategic financial maneuvers, including increasing operational liquidity and smart equity financing, aim to support revenue growth and sustain dividends.
  
• Reliance on legislative changes and market conditions poses risks to revenue growth, funding strategies, and financial stability, potentially missing opportunities.

Catalysts

Chicago Atlantic Real Estate Finance, Inc.

• Expansion into new and growing markets, such as Ohio and potentially Florida with adult-use cannabis legalization, could substantially increase loan origination volume and, consequently, interest income.
  
• Conservative loan underwriting in anticipation of federal cannabis rescheduling ensures the company is prepared for adverse market changes, potentially mitigating risk and safeguarding net margins.
  
• The increase in the company’s revolving credit facility to $105 million provides significant operational liquidity for future loan originations, enhancing the ability to capitalize on new opportunities and drive revenue growth.
  
• Deployment of the ATM program for sourcing accretive capital, issuing shares at a premium to book value, suggests a strategic approach to equity financing that could enhance earnings per share by avoiding dilution at lower valuations.
  
• Management’s focus on attractive risk-adjusted returns and maintaining low leverage positions the company to sustain its dividend payments, potentially increasing its appeal to income-focused investors and supporting the stock price.

Assumptions

• Analysts are assuming Chicago Atlantic Real Estate Finance's revenue will grow by 4.2% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 67.6% today to 65.4% in 3 years time.
• Analysts expect earnings to reach $40.9 million (and earnings per share of $1.85) by about October 2027, up from $37.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 11.7x on those 2027 earnings, up from 8.2x today. This future PE is lower than the current PE for the US Mortgage REITs industry at 14.4x.
• Analysts expect the number of shares outstanding to grow by 4.06% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 5.8%, as per the Simply Wall St company report.

Risks

• The uncertain federal rescheduling of cannabis might not develop as positively as anticipated, limiting the expansion of the industry and potentially impacting revenue growth prospects.
  
• Volatility in the public markets could lead to increased capital costs or difficulty in raising future capital, affecting the company's ability to fund new loans and investments, thereby potentially reducing earnings.
  
• The company’s conservative approach towards growth and underwriting new loans as if federal legalization does not happen could result in missed opportunities should legalization proceed more quickly than anticipated, impacting potential revenue and market share gains.
  
• Dependence on significant portfolio growth in states transitioning from medical to adult use, like Florida, Ohio, and Pennsylvania, poses a risk if legislative changes do not occur as expected or are delayed, which could impact projected earnings.
  
• The company’s strategy of funding new originations primarily through its revolving credit facility and ATM program introduces risk if market conditions or credit terms become unfavorable, potentially affecting net interest margins and overall financial stability.

Valuation

• The analysts have a consensus price target of $18.4 for Chicago Atlantic Real Estate Finance based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $22.0, and the most bearish reporting a price target of just $16.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $62.5 million, earnings will come to $40.9 million, and it would be trading on a PE ratio of 11.7x, assuming you use a discount rate of 5.8%.
• Given the current share price of $15.67, the analyst's price target of $18.4 is 14.8% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.